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The Next Generation Of Insurance-Based Planning

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Using the latest VUL innovations to help S Corporation owners

By Brett W. Berg and David K. Smucker

The recent rebound in the equity markets plus the recent nonqualified deferred compensation legislation has revived the ongoing opportunity to promote reviews of nonqualified savings plans for business owners. For example, it is appropriate for C corporations to review their existing deferred compensation plans and potential for life insurance as an informal funding vehicle. Or, if no deferred compensation plan exists, C corporations can consider implementing such a plan.

But what about S corporations? Many advisors are seeking marketing campaigns for S corporations because S corporation owners often cannot take advantage of traditional nonqualified deferred compensation because of the pass-through taxation of S corporations.

Of course, S corporation owners need to save, too. The current environment creates a tremendous opportunity to help S corporation owners understand their options for creating meaningful nonqualified savings plans, especially using variable universal life insurance (VUL) for long-term potential cash accumulation.

In general, such nonqualified savings plans may be funded by taking additional income from the S corporation such as bonuses. In addition, todays products include valuable innovations. Carriers are lowering the mortality and expense charges to bolster cash accumulation and creating income management tools to manage withdrawals and loans. This generation of product development focuses not only on accumulation, but also on helping advisors manage the retirement income phase of insurance-based retirement plans. The products and services are more turnkey financial vehicles for accumulating, distributing and transferring wealth.

The Problem and Opportunity for S Corporation Owners: Pass-Through Taxation

The general tax-planning concept for nonqualified executive benefit planning is that life insurance premiums are paid with after-tax dollars. Therefore, it is tax-efficient for premium payments to be made by the person or entity in the lowest tax bracket. Accordingly, a tax-planning opportunity exists when there is a difference between the life insurance owners income tax bracket and the tax bracket of the business he or she owns.

No such difference exists for S corporation owners. Basically, the S election results in pass-through tax treatment for the S corporation owners. For income tax purposes, the owners are taxed on all profits whether or not such profits are distributed. The lack of a separate corporate tax entity means that nonqualified deferred compensation and split dollar do not offer any income-tax planning advantages.

Of course, S corporation owners can and should implement qualified plans to save on a qualified basis. In addition to adopting a qualified plan, what are the nonqualified savings options for the S corporation owner?

Insurance-based Retirement Plans Funded by Bonuses

Essentially, S corporation owners have the same savings solutions as everyone else with respect to their after-tax income. One of those solutions is an insurance-based retirement plan funded with bonuses.

An insurance-based retirement plan is a popular savings option, especially using VUL. In such a plan, the S corporation owner personally owns the policy. The premiums are funded through bonuses. Of course, the S corporation owner pays tax on the bonuses and places either all or a portion of the after-tax amount into a VUL policy. Usually the VUL policy is designed as a minimum non-MEC type of plan to enhance the potential cash accumulation in the policy. At retirement, the S corporation owner may take withdrawals from the policy and/or policy loans to supplement retirement income. Assuming that the policy does not lapse and is not surrendered, such withdrawals and loans will not be subject to current income tax. In addition, if the S corporation owner dies, the death benefit is paid to his or her beneficiary.

It is always critical for the S corporation owner to consult with his or her attorney and/or accountant to understand how such bonuses may or may not change current taxable income.

Bonuses definitely do not change taxable income. For example, lets say “Chris” is 100% owner of Chris Construction Company Inc., an S corporation. Chris likes the idea and value inherent in permanent life insurance and wants to put $50,000 a year into new coverage. Chris Construction Company Inc. generates $250,000 of revenue. Chris is currently drawing a $150,000 salary. The corporations profit is $100,000 after Chris draws his salary. All profits are passed through to Chris as the sole shareholder. Therefore, Chris is taxed on $250,000. If Chris took $150,000 in salary and a $50,000 bonus, the company profits would be $50,000. Such profits still would be passed through to him and he still would be paying tax on the entire $250,000.

Bridging the Gap between Cash Accumulation and Income Management

The main point is that the benefit of such a plan is the life insurance. Financial advisors create tremendous value by analyzing, evaluating and recommending the right product for the S corporation owners plan. In many instances, VUL with low mortality and expense charges and a well-diversified portfolio of equity subaccount choices will be important considerations to enhance the opportunity for cash accumulation. An equally important consideration today is the ability of the insurance carrier to help the financial advisor manage the income phase of the insurance-based retirement plan.

Insurance carriers are realizing the importance of the income phase. When clients are ready to take income from their policies, some carriers provide programs that simplify the income-management process. Such programs often include:

–annual review packages with current reproposals;

–fund-directed withdrawals for VUL policies; and,

–suspension of premium bills while the program is in place.

With such programs, producers help clients determine their income needs based upon a specified length of time or dollar amount. The programs typically allow clients to receive income on a monthly, quarterly, semi-annual or annual basis by either electronic funds transfer or check. Once their needs are determined, the process is automated for them. Such simplified processes mean less time managing withdrawals for the financial advisor and the client, which means more time for managing the overall financial planning for the client.

For S corporation owners, such income-management tools complete the nonqualified savings package, managing and bridging the gap between accumulation and distribution, and making the insurance-based retirement plan an even more valuable savings option.

Brett W. Berg, JD, LLM, CLU, ChFC is field director of advanced sales for Nationwide Financial in Columbus, Ohio. He can be reached at [email protected].

David K. Smucker, CPA, CLU, CFP, serves as advanced sales consultant for Nationwide Financial. He can be reached at [email protected].

Reproduced from National Underwriter Life & Health/Financial Services Edition, February 11, 2005. Copyright 2005 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.


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